Bursting Another Bubble?

Although not a snowflake is falling outside my window, if media reports are correct we are on the verge of getting that most odd of weather occurences: a February snowstorm in Albany. But, before I send my family down to my specially constructed weather bunker with a six month supply of food and water, I wanted to supply you with one more blog, so here it goes. . .

You can add another voice to the increasingly large number of FED officials expressing skepticism about the continued utility of the FED’s bond buying program that has kept interest rates historically low. In a speech Thursday that has gotten a fair amount of attention in this morning’s press, Federal Reserve Governor Jeremy C. Stein raised caution flags that the FED’s policies may be creating new asset bubbles. Although Stein did not come out and say so, if you follow his logic, then the FED has to choose at some point to either raise interest rates or suffer the consequences when over-valued securities that investors have sought in search of higher yields come back down to earth.

For example, he argued that recent trends indicate that banks are seeking assets and securities with higher interest rates and that “the added interest rate exposure may itself be a meaningful source of risk for the banking sector and should be monitored carefully.” While this is not itself an original critique, he further argues that it may be a “tip of the iceberg” indication that other less regulated institutions are seeking higher yields at greater risk, posing danger to the economy as a whole.

For those of you who have the time and are responsible for monitoring your credit union’s interest rate risk, I would suggest grabbing a second cup of coffee and trying to get through the entire speech. It is not only an implicit critique of existing FED policy but provides a great framework for those who debate the ultimate responsibility of the FED in protecting the economy. [Alternatively, if you are having trouble sleeping, just start reading it before you want to go to bed tonight. It is interesting but not exactly a page turner.]

For example, the FED’s statutory mandate is to maximize employment and moderate long term interest rates. By this measure, the FED is doing exactly what it should. There are no signs of inflation on the horizon and lower interest rates should in the aggregate encourage job creation by giving companies more money to invest. To its critics, this is exactly the mistake it made leading into the Great Recession, the policy runs the risk of encouraging speculation in areas such as housing since it provides people cheap money. The question is are regulators better positioned to prevent potential bubbles by, for example, toughening underwriting standards, or does the FED have a responsibility to prick bubbles before they grow out of control? I don’t pretend to know the answer, but it certainly is a question worth asking and it is a framework to keep in mind as you try to navigate your credit union through the vagaries of interest rates while accommodating anxious examiners.

Assuming I can dig out of the shelter, I’ll be back on Monday, but considering that not a snowflake has yet fallen and my daughter’s school is already closing early, I do have to wonder when Albany turned into Miami Beach when it comes to impending snow storms.